Nov 6, 2017

Doug Irwin on the History of US Trade Policy

The history of US trade policy has been guided by the “three R’s”: revenue, restriction, and reciprocity.
David Beckworth Senior Research Fellow , Doug Irwin

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Douglas Irwin is a professor of economics at Dartmouth College and a leading expert on trade economics. He rejoins Macro Musings to discuss his new book, Clashing over Commerce: A History of US Trade Policy, which examines the history of American trade policy from the late 1700s to the present. Doug explains how US attitudes toward trade evolved over time and how free trade became the postwar consensus. David and Doug also discuss some of Doug’s work on the gold standard and the Great Depression.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth: Doug, welcome back to the show.

Doug Irwin: Thank you very much for having me.

Beckworth: Yes, you're one of the few guests who've made a reoccurring appearance and we're excited to have you here, that you're live in the studio this time, so it's neat to have you back home board. I want to talk about your book, *Clashing Over Commerce.* It's a sweeping history of trade in the US. Give us an overview of it and then we'll kind of delve into more specific parts.

*Clashing over Commerce*

Irwin: Well, it covers the history of US trade policy from 1763 right up through Donald Trump. So, it is quite massive in terms of its scope. What I've tried to do is, the last really big history of US trade policy was done by Frank Taussig who was a great economist, a Harvard professor. He was first chair of the US Tariff Commission around 1919 or so. He wrote a book called The Tariff History of the United States, which is a great book, but his last edition was in 1930, and we've had a lot of history since then and we've learned a lot about the period he was writing about in terms of cliometrics and economic constraints going over data.

Irwin: I thought, I didn't write this because of Trump. I've been working on it for many years, but it just so happens it's coming out at a moment where people are sort of talking about trade once again and even the administration brings up figures from the past, Andrew Jackson and Alexander Hamilton. So, sort of lucked out in terms of the timing, but it's just to provide sort of an overview of the political and economic history of US trade policy from the founding of the country to the present.

Beckworth: Yeah, and you had a recent Wall Street Journal article talk about as well that it kind of plays off of that, but I think it's very topical today, but even before Trump and now that there's, at least in my view, an ongoing confusion over trade policy. It's always something that's hard to explain. It's easy to maybe fall into protectionist tendencies. It's a never ending struggle against, for you as a trade economist, right? You have many books that make this case.

Irwin: Right. But the point of the book is not to make the case for or against trade. It's really just to say, politically, how did things evolve? What were the economic and political factors behind whether tariffs are going up or down or we're moving towards being more open or less open? But you're absolutely right. There's a perennial debate over trade policy. In fact, I open the book with a quote from James Madison writing in the Federalist papers saying, "We're going to have these clashes within a country. Differences of views, difference of interests over trade policy." He said, "To what degree should we be protecting domestic manufacturers from foreign competition?" He said, "There's no one way of answering this question and it's going to be one of our political struggle." And so the book is really about that political struggle about whether tariffs should be higher or lower, should we have protection or be more open and closer to free trade?

Beckworth: All right. What are some of the major themes of the book?

Irwin: Well, I sort of divide the history into three periods. I call them the three Rs, revenue, restriction and reciprocity. When you think about what can government use trade policy for? One is it's, we're talking about taxes on imports pretty much, tariffs. So, you can use those to raise revenue. You can use those just to block imports to protect domestic firms from foreign competition or you can use it as a bargaining chip to achieve reciprocity or level playing field or something like that. We see each of those three things throughout US history, but you can really divide the history into three areas where one of those is sort of the predominant motive of driving US trade policy. We're talking over 200 years of us trade policy history, but these periods of either where the revenue is most important or restriction protectionism is most important or reciprocity, they tend to be very long periods and there's a lot of status quo bias within them.

Irwin: I talk about the structural features that lead to the status quo bias, why it's very hard to deviate from the status quo in any one of these periods. Then the question becomes, how do you shift between these periods? And there's sort of these big shocks which we can get into. One is the Civil War, which leads to a transition from revenue to restriction. Then we have the great depression, which leads to a shift from a restriction to reciprocity.

Beckworth: Yeah, it was fascinating looking at these three regimes, these three Rs, that there was so much continuity for such a long time for each of those. I guess that's a little surprising to me. Was that a surprise to you or is that well understood in the literature?

Irwin: It was a little bit surprising. I don't know, you've seen the HBO series, Veep with Julia Louis-Dreyfus. It's a fictitious program. Obviously she's the vice president and then becomes the president. She has this campaign at one time where her slogan is continuity and change. Of course, that's hilarious because you can't have continuity and change. But actually that's a description of US trade policy because the continuity is within one of these periods. There's, as I mentioned, tremendous status quo bias, but it's never an accepted status quo. There's always a challenge. There's always a political debate and tussle over what direction policy should be. But then the changes, we do get these abrupt changes in the regime types.

Irwin: I think the structure, the status quo bias comes from the fact that when we have a certain trade policy regime in place, any change is going to be taking something away from someone and so there's great political resistance to doing that. When we have a regime of high tariffs from the Civil War up to the great depression to reduce those of the Mark Tessler of Peterson's too, once had this great quote from someone saying, it's an unnatural act to reduce those because you know who you're going to hurt. Who's going to benefit, it's going to be a little bit more diffuse and so politicians won't act that way.

Irwin: In fact, what's sort of interesting about the current regime, which where we have low tariffs and we're in with Trump, is he's finding it a little bit difficult to raise tariffs because he's finding there's resistance. You're also going to be taking away something from when you have low tariffs. Yes, you're giving something to someone, but you're also hurting others and they don't want to deviate from what we have right now. So there is the status quo bias I think in politics.

Beckworth: Like with still in Trump, right?

Irwin: Exactly. So, it sounds very easy on the campaign trail to say, yes, we're going to protect steel jobs, but all of a sudden, when you have power and you actually have the potential to do that, the steel users, exporters are worried about retaliation against their products. So agricultural states are opposed to that. And all of a sudden, the opposition sort of comes out of the woodwork and it's not quite as easy politically to do it.

Beckworth: It's been fascinating to watch. I had Caroline Freund on the show recently and we talked about how all his talk about changing trade really hasn't manifested itself because it has been more challenging. He's realizing, or at least his staff is realizing that there's many parties involved and there's winners and losers. Even PPP, there was an article that came out on Political, I'm sure you saw where all these farmers had invested massively in expansion because they believe they're now going to have all these foreign markets open to them, but now Trump pulls out of PPP, and these are the folks who voted for Trump, and they're kind of like, "Why did we vote for this guy?"

Irwin: Exactly. That came up with NAFTA too. In April, I believe, the president thought, it's time to pull out of NAFTA and he's going to do this very precipitously. Once again the Secretary of Agriculture and a lot of the members of Congress from ag States called or wrote to the white house saying, "Don't do this. We depend on exporting to Mexico. We'll really be hurt if you do this." When you think about the political debate over the last year, NAFTA has just gotten this horrible bad name. It's really been beaten up, loss of jobs, this, that, and the other thing. And now finally, went, okay, so let's get rid of it. Well, wait a second. There's a lot of opposition to doing that because those pro-trade constituencies tend to be relatively quiet.

Beckworth: Who would've thought it's complicated.

Irwin: It's complicated. That's right. Yes, it's not just not like healthcare.

Beckworth: Healthcare.

Irwin: Right.

Beckworth: Where he said, who would've thought it's complicated. Yes. Well, let's get into these three periods, which are again, summarized by these approaches to tariffs. The revenue period, which I believe is 1763 to 1865 and there's the restriction period of 1865 to 1932 and the reciprocity is 1932 to the present. Let's start with their revenue one. Tell us, how does that section start that period start.

The Revenue Period of Tariffs and Trade: 1763-1865

Irwin: Well, actually, it's sort of interesting. Once again, the book has as much political history as it does economic history. Even I hadn't quite realized how much we owe the constitution to trade policy in some sense. Under the articles of Confederation, Congress couldn't levy taxes. It was dependent on requisitions from the States. One of the reasons for having constitutional convention that Madison and Hamilton and others wanted was that the central government needed to pay its debts, and it could only pay its debts if it could raise taxes and so import tariffs are the most efficient way of raising taxes. Back in like a postcolonial period, we didn't have W-2s the income tax wasn't sort of feasible, even sales taxes would have been invaded and very difficult to collect, but imports just come into, half a dozen major ports in the US you can just tax the goods right there.

Irwin: All the founding fathers recognized that tariffs would be the main way of raising revenue. We need to give Congress the power to revenue. We need a constitution that'll enable that. We got the constitution, which gave a Congress that power, and the second act that Congress passed was the Tariff Act to raise revenue. It was that the way of raising funds to pay debts. The debate was all about how high should tariffs be to raise revenue. So, that was really a key consideration just in terms of the political founding of the country.

Beckworth: So Alexander Hamilton wasn't a protection. He was just someone thinking more about raising revenue for the government.

Irwin: Yeah. There's sort of this image of ... well, Hamilton wrote in 1791, their report on manufacturers. Of course, that's a famous, justly famous report. It's incredibly well argued, very sophisticated reasoning. But he does say that we should be promoting manufacturers. That's sort of a keyword, promotion rather than protection. So, he really wanted subsidies and other prizes and tournaments to encourage manufacturing in United States. He didn't really want to raise tariffs or block imports to any significant degree. Certainly, the way he acted as secretary of the treasury, he resisted a lot of pressure to raise tariffs to very high levels to protect domestic manufacturers because he was, first and foremost, concerned about funding the debt and making sure the federal government was solvent. Imports were the tax base.

Irwin: That's the thing you wanted to tax and you don't want to shrivel up your tax base through high protections duties. You want to keep a steady flow of imports coming in and then just levy an efficient tax on top of that to a garnish as much revenue as possible. He so resisted some pressure from import competing manufacturers, which were a very small group back in the day, that they started shifting towards supporting Jefferson and Madison and people you'd sort of associate with less government and Laissez-faire perhaps, but they were also had a much greater anti-British animus and were much more willing to strike back against Britain through high trade barriers. That's why we had an embargo. We had a lot of trade measures against Britain, not under Hamilton's rule as secretary of the treasury, but under the Jefferson and Madison administrations.

Beckworth: We talked about this the last time you came on the show, but it's worth repeating. To say that Jefferson embargo was truly an embargo. It really cut off the rest of the world and it was devastating for the US economy, right?

Irwin: Right. Basically, the reason is, is US shipping was getting harassed by the French and the British navies. We didn't have much of a Navy to provide maritime protection. So Jefferson said, "Well, our alternatives are war and we really don't want to do that. Or we just pull all of our ships off the seas." So, basically the embargo was any American ship in port couldn't leave to export goods and any US ship that was already on the seas could come back, offload its goods, but then couldn't travel. This was an effect for a little over a year.

Irwin: You can just imagine. Think about president Trump saying, "We're not going to have higher tariffs. We're just going to stop trade for a year and get rid of the trade deficit that way. No trade." There's a pretty major step. Obviously it wasn't so much for economic reasons, and Jefferson was more for security reasons, but had a devastating effect on the economy. You can imagine we were very trade dependent economy back then. You shut down all the ports, you're not going to be very popular in Baltimore and in Philadelphia and in Boston and elsewhere. So, there's a lot of pressure for, by the end of the year, 1808, to smuggle goods out is irresistible, but it took draconian enforcement measures. I've estimated that the welfare cost or GDP cost was about 5% of US GDP in one year. When you think about the great recession of 2008, 2009, how much did GDP go down in the US?

Beckworth: About 3%.

Irwin: 3%, maybe even a little less than that. Here's we're losing 5% in six months. So this is just a major impact on US economy.

Beckworth: Yeah. So is far worse than the Great Recession then. Do you think that, just kind of stepping back, was that embargo the most costly trade experience we've had or would you attribute another one?

Irwin: Well, the thing about the embargo was only about for about a year. It's hard to compare different periods because obviously the circumstances are different. But when we declared our independence, Britain enforced embargo against us and we had a non-trade sort of act against them. When you look at us trade from 1775 right before the declaration of independence, when we basically stopped trade, up through the Treaty of Paris, which was 1783 and then trade was resumed between the US and Britain, that was a good long stretch, five, six, seven years or so where trade was either as not zero, but very low levels, partly because there was a war, partly because of policy, and that economic strains have looked at as being really devastating period for the US economy. Much worse it's been said than the great depression. Very, very difficult times.

Beckworth: That's interesting. All right, so during this period, there does arise regional conflicts over tariffs and there's the famous tariff of abominations. Tell us about that development.

The Tariff of Abominations

Irwin: Sure. Well, you're certainly right about one of the themes of the book is that you can think about US trade politics as being a competition among regions for which policy we're going to have in place. The South tended to be much more export oriented. At this time, we were exporting a lot of cotton, obviously tobacco and other things. So, it was sort of the export platform for the United States. The North had more industry which was facing foreign competition. So, the question is not just during this period, but throughout history, how the different regions have had different economic interests and how that plays out in Congress. Even though I've said the period before the Civil War was one in which revenue was sort of the dominant concern of Congress, there's always protectionist pressure.

Irwin: In the 1820s, this came about with Henry Clay, the American system, trying to raise tariff levels to help out manufacturers in United States and sort of culminated in what became known as the Tariff of Abominations which is raising tariffs actually to very high levels in 1828. It was largely for political reasons. It really wasn't for economic reasons. So, it gets to another theme of the book, which is that politicians sometimes use the tariff for their own purposes. It's not as though they are the instrument of special interest groups. There's the sort of stereotypical public choice which just uses politicians as mimicking or reacting to economic interests. I find in a number of periods in US history where it's the other way around.

Irwin: Actually, politicians are using economic interest for their own political ends. The Tariff of Abominations is an example of that because the US economy was not being overrun by imports. We did not have a high unemployment rate. The economy was doing pretty well. So there's no, in some sense, demand for higher protection, but the politicians want to use it for their own political purposes. What that did was obviously raised terrace to very high levels. The South, and South Carolina in particular, had extreme objections to this, said it was unconstitutional. We might leave the country as a result of it. It caused a big political crisis in United States that wasn't defused until 1833.

Beckworth: Going into Civil War, tariffs were going down then, right?

Irwin: Yeah. Once again, there is this North South conflict over tariffs. Absolutely, and the 1820s is sort of the heyday of that. This is when John Calhoun comes out with rights of secession and the ability of States to sort of veto national laws. I'm blanking on the precise term that he had for that, but a lot of conflict. The point is that the South won that battle with the compromise of 1833. So you sometimes hear, well, because of this North-South discord over the tariff, that was one of the causes of the Civil War. It wasn't just slavery, or even some people say it wasn't really slavery, it was really the tariff.

Irwin: I just don't think that's true. The South won the battle. The 1833 compromise brought tariffs down in a phased out a way. Tariffs were cut again in 1846. They were cut again in 1857, and by the outbreak of the Civil War, 1860, the average tariff is less than 20%, which is basically where the South wanted it. So the South won that battle. Yes, there had always been North-South conflict, but it was really had been diffused by 1860.

Beckworth: Oh, this is good to know because, as you said, this often comes up. Discussions about, was the South unfairly harmed by tariffs and was that something that led them to fight the Civil War? But you show pretty conclusively that's not the case.

Irwin: Right. Now, certainly the South was harmed by the tariffs in the 1820s. Economic historians have done calculations about what the burden was. It's not a very high as a share of total US GDP, but one can understand why there was an aggrievance, but that aggrievance had been was gone by the 1840s and '50s.

Beckworth: Were southerners in the 1860s, late 1850s, were they still sore over the tariff abominations. Did they say, "Look, I did it to us once, they can do it to us again." Was that maybe at the back of their mind?

Irwin: There's always regional jealousy. I'm not sure that the South worried about the tariffs coming back, but they certainly were worried about interference with slavery and public works. The South is very much against the internal improvements because all the internal improvement spending was going to take place in the North and in the Midwest, not in the South in terms of building canals and things of that sort. So there's always regional jealousy, but the tariff matter had by 1860 pretty much evaporated. Now, one sort of caveat is that Congress passed in 1861 the Moral Tariff, which raised tariff rates.

Irwin: But the reason that went through is because after the election of 1860, Abraham Lincoln, the South walked out of Congress. And so then the remaining northerners could pass that tariff, but if the South had stayed in Congress, they could've stopped that. Sometimes they'd say, "Well, they raised the tariff in 1861 and that would have hurt the South, but the South had already walked…

Beckworth: Exactly. Yeah. All right. That gets us to the second phase of trade history, and that's the restrictionist phase. This is one of the first exogenous shocks you talk about, right? Something big. So we have this trajectory for trade and all of a sudden, this big shock, the Civil War comes and puts us on a different trajectory. So tell us about that.

The Restrictionist Period of Tariffs and Trade: 1865-1932

Irwin: Yeah. Once again, as I said, by 1859, 1860, tariffs were pretty low levels, and if we had not had the Civil War, presuming that would have continued for some time and it would've been very interesting to see how the US would have developed in late 19th century under a relatively low tariff regime. But we have the Civil War and the North needs to raise revenue. It's massively expensive proposition. They introduced an income tax, all sorts of excise tax, and of course the tariffs go up to sort of compensate for the increase in excise taxes. Tariffs go up. There's no political opposition to that. It wasn't done for protectionist purposes. It was really to raise revenue for the war. But when the war is over, the question is, well, can we bring those tariffs down?

Irwin: First of all, you can't do that immediately because you have to pay off all the debts. The tariff revenue did not nearly come close to paying for the whole war. Second of all, you've built up all sorts of special interest behind the tariff wall now, and so they're going to resist. In fact, they did resist any sort of cuts in tariffs. That's where he gets sort of this, not just a status quo bias, but you get this ratchet effect where once they come up, they're not going to come back down because there's vested interest behind them. That's really the story of the 1870s, 1880s, 1890s of everyone sort of recognizes that tariffs probably should come down. We have huge fiscal surpluses.

Irwin: Protectionists considered it pretty extreme, but politically, it's just impossible to bring the tariffs down.

Beckworth: These are the Republicans, right? Why were they so protectionist? They ran the industries. What was the motivation?

Irwin: Yeah, so once again, it all comes down to regional representation. The political strength of the Republicans was coming from the North, which is where a lot of manufacturing is. So, they don't want imports coming in and the Democrats are largely in the South, which is still export oriented and they want a lower tariffs. But the North was much more politically powerful in the post Civil Ear period. So it was just ... regional interests explain it. But even the few times that Democrats get in, and they really didn't have many political opportunities, the Democrats were divided. Yes, the Democrats in the South wanted to cut tariffs, but a lot of Democrats in the North, they would deviate from their party. They represented constituencies in Pennsylvania and they didn't want tariffs cut. You have the Republican party strongly unified behind protection and then the Democrats are divided between the North and the South and so they're sort of ineffective as a force to bring tariffs down.

Beckworth: You mentioned that the debt being and one of the issues that tariffs state high in addition to these protectionist impulses. I wonder if there's any overlap there though, that the Republicans saw it as a convenient excuse to keep them up and then they segued into, well, we keep it high for our business as well. Was there any of that do you think?

Irwin: Oh, there's a huge issue during this period. In fact, there's something called the great tariff debate of 1888 about what should we do with our fiscal policy with respect to trade in some sense. The issue was I called it a fiscal crisis. It was a major fiscal crisis in the sense that US had these fiscal surpluses, which were just astronomical. The government was taking in $2 for every $1 it was spending. Why is that a problem? The Republicans tried to spend their way out of it a little bit through Civil War pensions, but still the money was just coming in. There's a Laffer curve debate during this period. So the Democrats said, "Well, since we have the surplus, the obvious solution is to cut taxes." In other words, cut tariffs.

Irwin: And the Republicans said, "No, if we cut tariffs, that'll encourage more imports and we'll get more revenue. So we have to raise tariffs to reduce the revenue." What's interesting is Republicans and Democrats always seemed to be on the opposite side of the Laffer curve, where Democrats think that raising or lowering tariff rates would raise or lower revenue, and Republicans think that if you raise tariffs, you'll reduce revenue and if you reduce tariffs, you'll raise revenue.

Beckworth: Laffer, he thought he was the original one who wrote it on a napkin, but ...

Irwin: Right. That was really the debate in the 1880.

Beckworth: Interesting. Well, I'm bringing this up because I'm a little bit familiar with this period in terms of some of the monetary issues. One of the things they had during that period was the national banking system which was introduced in the time of the Civil War. The amount of money that these ... if you're chartered under national bank, and most of the banks became national charters, they had taxes that taxed the state banks out of existence until the late 1800s, but so a lot of national banks and the money they issued had to be backed by national bonds, government debt. The amount of money that could be issued was literally tied to the amount of depth there was.

Beckworth: As you mentioned, the debt's going down during this period, which caused problems for the amount of money supply, very rigid and elastic money supply. As you know, whenever the farmers went to harvest, there wasn't enough money around. So they had to adjust the law several times because the national debt was going down.

Irwin: Right. That was one of the big worries by the end of the 1880s was that the treasury will just be accumulating all this surplus, drawing it out of the banking system. If we extinguish the debt, what's going to happen to the money supply and capital for lending?

Beckworth: It is a unique set of problems we never had to think about today. It's really a different world, different set of circumstances. Another interesting thing about this period because I've looked at it a little bit, is also is this postbellum deflation period where, from almost 30 years you have sustained ... Some of it's severe during these 1870, 1890s downturn, but there's a secular, overall secular decline in prices as well. There's the agrarian revolt against this. There's William Jennings Bryan who appears on the scene. I imagine some of this has to overlap with the trade issues then, right?

Irwin: It is sort of indirectly related. Certainly, politicians would use these arguments. Protectionists would say, "Look, tariffs don't cause higher prices. Higher prices are falling." But that's the price levels fall because of deflation. It's not as though tariff leads to lower prices. The arguments get muddied in that way.

Beckworth: Yeah, very fascinating period. A lot of structural changes going on obviously during that time. All right, I think the end of the restriction period takes us up to the Smoot–Hawley during the early part of the great depression. So tell us about Smoot–Hawley. What was this motivation? What effect did it have?

The Smoot-Hawley Tariffs

Irwin: Well, that's another example where there's no real demand by constituents or by the private sector for these higher tariffs, but politicians are using it for their own political purposes. This period very well is, that 1929 was a boom year. Unemployment rate was only about 3% or so. The stock market was rising. This is the roaring twenties. The economy is doing very well. We don't have big trade surplus or trade deficit. There's no real trade problem, but there was sort of a farm problem. Calvin Coolidge had twice vetoed price support legislation the Republicans in Congress had proposed. So, the issue was how do we help farmers? So, Congress latches onto the tariff and says, "Well, let's raise a tariff on imports as a way of helping out farmers."

Irwin: First of all, farmers weren't enthusiastic about that because we were a net exporter of most farm goods. Not so much for sugar or a wool, but for grains and everything like that, we're a big exporter, so a tariff wouldn't help you help them on that. Once they sort of opened that up for revision that's when the manufacturers came in and said, okay, well, we want higher tariffs too. Once again, it really wasn't economically necessary. There was no demand for it at the time, but we just got this big increase in tariffs really before the great depression had tipped into it. Although Smoot-Hawley wasn't passed until the June of 1930 after we'd sort of entered into the recession, but it was already baked in the cake, so to speak, by the summer of 1929. It was an unnecessary gratuitous piece of legislation that had huge consequences for the US, the depression and moving forward.

Beckworth: Now, most people don't say it was the main reason for the great depression, but it definitely added injury to insult, it definitely added salt to the wound, made it worse than it would otherwise have been.

Irwin: Right, because there was a lot of retaliation against the US, both explicit and implicit. The biggest retaliation came from Canada. This really sort of backfired against the US in terms of even farm exports. There's one example that Cordell Hull used to always point to is that we imposed a higher tariff on eggs, but we are a huge net exporter of eggs. What Canada did was match our tariff on eggs and so our X scores plummeted to Canada in terms of eggs, and so it just didn't help out egg producers or chicken producers at all.

Beckworth: Wow. That period was really one of colossal policy errors on many fronts.

Irwin: It wasn't just tariff barriers were raised against the US, but they're largely discriminatory. So Canada went in for Imperial preferences, giving preferences to British manufacturers over ours. So did other countries and was really the rise of discrimination as much as the rise of trade barriers overall, which was damaging to the US.

Beckworth: So the Smoot-Hawley, it was retaliatory and other countries responded. Did it really create a big shock to the global trade apparatus, to the trajectory of global trade?

Irwin: It was just one of many steps taken during this period. Obviously backfired against the US, but when you think about the trade wars or of the early 1930s, I'd say equally problematic issue was when the financial crisis really hit Europe in 1931 and then Germany and Eastern Europe, peon countries being and imposing exchange controls. Then Britain devalued or went off the gold standard in September of 1931. That led to a lot of retaliation against Britain because now they had a "undervalued currency." And so other countries that stay on the gold standard want to impose special tariffs on Britain because of that and the whole British sterling block. So things really unrivaled in 1931. There's a retaliation against the US. That all happens in 1930 or so, but 1931 was sort of a denouement of what moving into the depression, really bad trade policies with exchange controls and other things coming to the fore.

Beckworth: Okay. Now, as bad as this discussion is, it ultimately served ... the great depression itself served as a major shock to push us back in the other direction, which is a little bit counterintuitive because in our previous conversation we talked about how recessions often make people more protectionists. Trump comes out of the great recession, the populism in Europe, Ross Perot in the early 90s. Help me understand this. How did this push us in a more healthy direction?

Irwin: That's a really good way of putting it because it is sort of unusual, but I think the fact that we just tried protection and it was followed, and its consequences or in it's ...

Beckworth: It's very clear and vivid.

Irwin: Exactly. So, you don't want to try more of that because it didn't seem to work out. You mentioned that we now don't think that the Smoot-Hawley Tariff caused the great depression, but a lot of people at the time sort of did, and it was sort of a post hoc ergo propter hoc. What happened? We had a stock market crash and we impose these high tariffs and then the economy goes to pieces. Well, what could have caused this? They didn't have the monetary interpretation back then so much. Well, it must've been the stock market crash and the higher tariffs that caused it. That's the first real sense in which tariffs got a bad name among the population. Then the fact that, we just tried this trade policy experiment, it didn't really work out. We don't want to double down on it. We have to think about something else.

Irwin: I think here's where the retaliation is also key because that was a discriminatory against the United States. Our exporters all of a sudden, began to wake up and take notice saying, "We're being locked out of foreign markets because of what we just did." So, when Cordell Hull and the Roosevelt administration comes in, Cordell Hull was the secretary of state who want to move us in a different trade direction, they made it their mission to reduce the burdens on US exports in other countries. So that's where this idea of reciprocity came from.

Beckworth: Very interesting. Hopefully we won't have to repeat that mistake under Trump. But as we said earlier, Trump has found that it's more complicated than some of his rhetoric.

Irwin: Also, this gets back to the theme that, it's not just special interest driving things. Politicians can drive things because when Cordell Hull said we want a policy reciprocity, it's not as though that's what all the export interests were demanding. He sort of had that policy innovation in his head and pushed it, and then the export interest came behind him saying, "Oh yeah, that's a good idea. We'll support that." Once again, it wasn't the interest leading the politicians, it was the politicians leading the interests.

Beckworth: Not to be cynical or anything, but do you think politicians today could be that exogenous force?

Irwin: At certain points in time? Once again, I can't identify all the conditions under which political entrepreneurship really works, but there are certain points where…

Beckworth: Okay. There's still hope.

Irwin: There's still hope. Yes.

Beckworth: I say that because today there's social media, there's Twitter, there's 24/7 cable news. There just seems to be, again, this is just my anecdotal, probably wrong impression, that politicians are much more sensitive to their environment, where this would require them to have a spine, to put a step forward and hopefully the masses would follow them. It's still possible what you're saying.

Irwin: It is. In fact, I think we see that today with the Jones Act, which is the shipping restrictions that we've had since the 1920s or so. Economists always said, why do we have this? It's protectionist. It's very costly and inefficient. There's sort of this crisis where we can't get goods to Puerto Rico very efficiently and so there's an opportunity. Senator John McCain and others who said, let's make the exemption permanent for Puerto Rico if not abolish it. So, we're having a debate now about the Jones act, which before it was impervious to criticism and now it's sort of obvious what the costs are and so there's this opportunity to possibly get rid of it. Not saying that's going to happen, but at least there's this opening.

Beckworth: Yeah, there's a hope that it might ... I guess, comparing this to the great depression, and you need both a policy entrepreneur and some kind of shock, kind of perfect storm of things lining up so people can see what damage the Jones Act does as well as someone who's willing to take the lead.

Irwin: Exactly, and we can just see what the damage was from Smoot-Hawley because of the discrimination against US exports. So it made it demonstrably tangible. It wasn't something abstract.

Beckworth: That's fascinating. The average person realized, man, these trade Wars are bad. They've harmed ... even if the interpretation was partly wrong. Even though, as the… I regret that it took so long for Milton Friedman's message to get out. But maybe that's one positive side effect that because we didn't really have the correct understanding, it led to another understanding which led to more trade liberalization, kind of a weird twist of fate there. Okay. This opens up this shock to great depression, puts us on another trajectory toward more engagement in the world. Did our foreign policy also play a role in that?

The Reciprocity Period of Trade and Tariffs: 1932-Present

Irwin: Yeah. Cordell Hull is secretary of state in 1933, and in 1934 in particular introduced into Congress this idea of reciprocal trade agreements. Well, first of all, it changed the locus of US trade policy from the Congress to the president. So Smoot-Hawley was the last time Congress, passed a long trade bill specifying the rates of duty on imports on every 3,000 items in the tariff code. So Congress gave that up. Now, it can be set by the president in the context of negotiations. You can declare a proclamation reducing tariff rates if the trade agreement had reached. Now, it has to be subject to congressional approval of course, but not initially.

Irwin: It wasn't a game changer in the 1930s, but it did move us in a different direction. The game changer was really world war II where the US saw, and both political parties saw that we can't fumble the peace after World War II the way we did after World War I. After World War I, we didn't join the League of Nations. We raised tariffs again, we became isolationists and we had to go on a different path. Trade policy was sort of bound up in this new foreign policy for the United States of openness, engagement leadership in the world. One of the areas of leadership was trade. So after World War II, that's when we got the general agreement on tariffs and trade where we don't reach these smaller bilateral agreements that were reached in the 1930s, but we have a bigger multilateral architecture for reducing tariffs around the world.

Beckworth: Now, was the World War II experience the lessons that you mentioned, the League of Nations, all these issues that push us further in the direction of more engagement with the world, more trade. Was this something widely understood by the average American or was it just more of the policy entrepreneurs who understood this and ran with the idea?

Irwin: I think it was widely understood at the time. Even up til 1940 or so, the Republicans were opposed to the Cordell Hull's policy and reciprocal trade agreements. I think in their election platform, 1940, they said that they would repeal the Reciprocal Trade Agreements Act and go back to the old system. After the war, they didn't say we'd go back to the old system, they'd say we want to modify it in certain ways, but they sort of went on board and accepting the way things had moved. The key Republican figure, there was Arthur Vandenberg, a Senator from Michigan who was sort of isolationist in the 1930s, but by 1943 or so, he basically said, "The world's changed. We have to be engaged and we have to support these trade agreements."

Beckworth: Well, that's remarkable. Such wide base support for trade policy. Whereas today, you see it going in the other direction and course we've had the China shock, we've had globalization, which can maybe taint that, but it's fascinating there can be such a wide base support for trade.

Irwin: Well, it's a very unique period in us history for about 20 or 30 years after the end of World War II where this is this bipartisan consensus. And it really began to break down after the end of the cold war. For foreign policy reasons, that brought the parties together in terms of trade, and it's really the only period in US history where the parties really agreed. The whole book is just littered with Republicans attacking Democrats and vice versa over which direction trade policy should go. But the 1950s, sixties and seventies and into the 80s, they're squabbling over trade. There's issues, but pretty much everyone's on board that we have to keep the system open. With the NAFTA debate, that's the first time we really see some big divergence. Of course, that's the post-Cold War about, is this good for the economy?

Irwin: Before, it would be posed as, it's good for the economy because it's helping out our Western allies and building up strong economies against communism, Western Alliance and all that. Now it's not so much we care about the alliance, is we care about ourselves, and that brings out sort of protectionist pressures in a different way.

Beckworth: Very interesting. Well, we can thank the Soviets then for promoting trade in the US, at least the Soviet threat. Okay. So much to this book. Again, I really encourage our listeners to go out and get it. It's out right now as this podcast is being placed. Make sure you get your copy ordered. This brings us more up to the president as you mentioned, NAFTA. To bring this forward and tie it to the present, you have an article, just came out a few weeks ago in the Wall Street Journal and it was titled *Steve Bannon's Bad History.* So a lot of what we touched on is in this, but tell us how does he get his history wrong?

Steve Bannon and Bad History

Irwin: Well, economic nationalism has always been a theme in the US context. Even the 19th century, we had protectionists saying this is America first trade policy and all of that. What the economic nationalist today and Steve Bannon I guess is sort of the head of that, and Trump in terms of his instincts sort of buys into it, is that our wealth has been sucked out of us. This is what Trump said in his inauguration address. Protection will preserve our strength. We've wiped out the middle class and the American economy is sort of the zero sum game where they've gotten rich and they've got rich at our expense.

Irwin: There's a narrative among the economic nationalists are appealing to history and Hamilton and Andrew Jackson and saying they put America first and we grew into a rich economy behind high tariff walls. That's really not the case, at least in terms of the way I and other economic historians have looked at it. First of all, the US has always been a pretty rich country. So Jeffrey Williamson and Peter Lindert have a recent book looking at the American wealth and GDP way back to the colonial period. We've always been a very rich country, which is one reason why we've been a magnet for so much immigration throughout the 19th century.

Irwin: They say that we overtook Britain much earlier than other economic constraints had thought. We've always been a very high wage wealthy economy prior to tariff walls prior to industrialization. Then when we look at the post-Civil War period when we had very rapid economic growth, economic nationalists will say, "Well, we had high tariffs then and we grew really rapidly, ergo one caused the other, but it's really not the case. We grew very rapidly because we had a lot of immigration coming in, so the labor force was growing very rapidly. We had a lot of capital accumulation because the national banking acts you were pointing out earlier, particularly in the 1860s allowed the formation of a lot of banks, particularly in the Northwest, apparently in the Midwest where they could efficiently channel savings into productive investments, so capital accumulation was very high.

Irwin: But that capital accumulation wasn't so much in manufacturing. It was in structures, building infrastructure, things of that sort. In fact, it was really the service sector in the late 19th century. It was absolutely key to US growth. It wasn't manufacturing. We are already fairly large as manufacturing power. Obviously it grew a lot, but it didn't really grow a lot as a share of GDP. The whole economy was growing, and in terms of productivity and just sheer innovation, a lot of it was occurring in the service sector, not manufacturing, which was the one that you typically think is being protected by high tariffs.

Beckworth: What it is, they make the mistake of confusing correlation with causation during this period. You're seeing this rapid growth which occur of rapid industrialization. Rapid service sector, really rapid service sector growth. And then they see these tariffs and they go, "This must cause that," but it's completely backward.

Irwin: Right. This is not a unique occurrence. We've talked about Smoot-Hawley in the great depression. People said, we'll impose these tariffs, and then we had the great depression, therefore tariffs caused that. But we also imposed tariffs right after World War I. We didn't have a depression after those tariffs in 1922. Fundamentally, econ one point correlation is not causation. You have to dig deeper and really figure out what are the mechanisms.

Beckworth: I hate to pile this on, but I think it's a point worth stressing because not only is this casual empiricism lead to these false conclusions, but even some serious scholars, and I know I mentioned his name last time and I feel bad bringing it up again, but I think it's important, Ha-Joon Chang has written a whole book about this. You've written about how he gets the causation wrong. Just because something's correlated does not mean it's causal.

Irwin: Right. Now, it could be, but you really have to explore the mechanisms and tell us why it's happening. I'm just saying this happened and that happened. That's really superficial analysis.

Beckworth: But all the things you just raised, all the developments going on inside of the US, it's a much easier story to tell when they want to tell. The time we have left, and last time we were on the show, I did not get to do this or give it justice anyhow. I want to talk about the great depression a little bit more, in particular the gold standard because you have a fascinating paper that's titled, *Did France Cause the Great Depression?* This is more of a monetary paper. So we're moving from trade more into monetary economics. You've written several interesting papers.

Beckworth: You've written on the initial Great Depression as well as the later recession, 1937/38. But let's talk about the initial Great Depression. You conclude that, yeah, France did help ... France was an important part, at least of the story for the sharp contraction, the early part of the 1930. So how did France help cause the Great Depression?

France’s Role in the Great Depression

Irwin: Well, first of all, I should say this is an original to me. I was really just building on the insights of, first of all, Milton Friedman and also Clark Johnson and Scott Sumner. Milton Friedman or a preface to an English translation of the governor of the Banque de France at the time, sort of said after reading this memoir, if I could rewrite the monetary history, I'd change it a little bit and say France was partly responsible for the great depression. Then Clark Johnson had a great book on this period as well. So, my paper was just following up on that work. Basically, the story is, and this seemed to get missed in a lot of discussions about the origins of the great depression is obviously, the world was on the gold standard and France, when they went back on the gold standard in the mid 1920s pegged the Frank at an undervalued rate. So they had a trade surplus, they were absorbing gold from the rest of the world, and they didn't sterilize it.

Irwin: So, what happens is the gold just kept on flowing in and sort of like the US was to some extent, but when you look at the numbers, the gold acquisition was just massive. It really hadn't been sort of noted by other economic historians, and so I just wanted to say, what sort of deflationary pressure could this possibly be exerted on all the other countries by absorbing this huge quantity of gold? In fact, in researching the paper at the time, I was going through some old New York Times archives online, and there's one report where, I think it was in the New York times, where the Bank of France had to dig out its basement deeper to accommodate all the gold that was flowing in. They just had no space for it.

Beckworth: That's crazy.

Irwin: You might have the numbers at your fingertips. It was enormous.

Beckworth: Yeah. I believe I have these numbers correctly. So 1926, they had 7% of the world's gold supply. By 1932, they jumped at 27%. Does that sound right?

Irwin: Something like that. That's astronomical.

Beckworth: That's a huge… enormous.

Irwin: That's enormous.

Beckworth: A third of the world, but close to a third of the world's gold supply suddenly ends up in France.

Irwin: In one country that's not even one of the major players.

Beckworth: Right. Then on top of that, of course, as you mentioned, you also mentioned in your paper, the US did a little bit of this as well. They were also cheating. Gold inflows were coming in to the US and they weren't allowing the prices to rise correspondingly. Right?

Irwin: Exactly. That's what sterilization means is, if the gold came in and you monetized it, you increase the money supply one for one, then there would be a natural balancing act. Prices in France would have risen, the trade surplus would have declined and it would have collaborated naturally, but they didn't do that. So they're really demonetizing the whole world by acquiring gold, but then not playing by the rules of the game and inflating.

Beckworth: That's a good point to be clear to our listeners who aren't economists, that this mattered because the money supply was determined by the amount of gold. So you can think of maybe the money is applied, the money multiplier, all that was tied to the amount of gold. So if you suddenly suck up a bunch of the gold out of the world market, global money supply is going to go down. That's why this was the global great depression.

Irwin: Absolutely. Yeah. So, I traced sort of the world price level to what's going on in France and try to portion blame, if you will. I'm holding up quotations to the United States and France and France basically almost equals in that States in terms of its impact on deflation on the world economy.

Beckworth: Your paper, you mentioned between France and the US, at least half of the decline and the deflation, 1930, '31 can be attributed to those two countries. Had they both been responsible, and to be clear, there may have been a catalyst, a trigger, and then there's these other cascading, the stock market and panic and everything else ensues, but had that catalyst not been there, it could have been a very different outcome.

Irwin: Absolutely.

Beckworth: This goes back to a conversation I've had several other guests and this speaks to the interwar gold standard, why it did not work well. When you compare it to the classical gold standard, which is like 1870 and 1914, that worked relatively well, comparatively well at least. But this interwar one did not. And so you know, the classical gold standard process you just described, if golds come into your country because your goods were cheap or more competitive, more gold, more money, eventually your goods got more expensive and the gold would flow out to the other country which was now cheaper. That process was allowed to work. In a war period, it was not ... created the great depression. So the question is why. Your coauthor, you and Barry Eichengreen have co-authored before. He has a great book, The Golden Fetters and he makes the case in there that by the time you get to the interwar gold standard, there's more in franchisement.

Beckworth: Voters are more cognizant of this process and politicians are more sensitive to this. You're bound to have cheating. You're bound to have countries not tolerating the pain of a gold standard. Is that your view too?

Irwin: Sure. Here I defer completely to Barry who's done the seminal work on this. It was not an automatic gold standard on automatic pilot. It was a very much a managed politicized gold standard. In fact, it was called the gold exchange standard because of sort watered down. You can use foreign exchange reserves as part of your central bank reserves in addition to gold. It was just very different than the pre-World War I gold standard. Although I think economic strains have gone back and said the pre-World War I standard, it was not quite as pure ...

Beckworth: That was hunky-dory.

Irwin: Exactly. Yeah, but not nothing like the interwar period.

Beckworth: Right. But what, again, made that distinction is though, to the extent it did work before at 1914. It would have meant that if prices were cheaper somewhere else, the gold flows out of your country. You have a period of monetary, you use your money, prices fall, it might be painful. You get to tolerate more pain. You had to suck it up and maybe tolerate a mild recession, but what you did is you preserved the international order at the expense of domestic stability. You had more of a sessions domestically, but the international ... you didn't see any sustained trade deficits. But by the time we get to the interwar period, it's just politically not possible to do that now. I thought this was… the central banks, they're the ones they were managing. But I would argue they were managing because of this political economy now.

Beckworth: That yes, they had to manage the gold standard because there's this expectation that it will be managed and we'll first and foremost worry about our domestic economy over the international one. I'm saying all this to get to my big question. Does it seem likely you could do a gold standard today given the political economy that we saw during the interwar period?

Is the Gold Standard Possible Today?

Irwin: Oh, well, I think that, once again, the demands on government to ensure domestic economic stability to take priority over any external objective. Actually, Michael Bordo and Anna Schwartz have a nice paper in the open economies review, I think it's called, just this conflict between domestic objectives in international objectives or external objectives and how that conflict will always be resolved in terms of the domestic. You can't say, well, we're going to suffer a recession because we're going to maintain a fixed exchange rate or ...

Beckworth: We see that today, don't we? We were talking earlier before the show about like China. China ran a current account surpluses of 10% of GDP you said?

Irwin: By 2008. Their current account…

Beckworth: So they were massively sucking demand out of the world. They had a massive effect on the rest of the world. The US has around a huge current account deficit, but China was thinking about themselves. They have all these people from the countryside move into the cities they got to employ. I'm sure they're sensitive on the margins to what's going on outside the countries, but it's not like the gold standard. They're, first and foremost, let's keep our people happy.

Irwin: Right.

Beckworth: Yeah. I think that's one of the challenges in making something like the golden standard work again. Well, let's get to, it's a very fascinating period. Papers like yours about France, the great depression, the gold standard and Barry Eichengreen's work and others, at least in my mind, still sound very, maybe egotistical. I think you can't do history without economics. You can't really understand trade. Trade the money system, all these things are so important in understanding what happened in nine consensually the US. Anyways, I think it's two disciplines that really complemented each other.

Beckworth: Well let's go to your paper on the second recession within the Great Depression. So we had the 1929 and the 1933 contraction, and there's the 1937-38 recession. Tell us the standard interpretation of that and then what's your kind of unique angle on it?

The 1937-38 Recession

Irwin: Well, the '37, '38 recession is a fascinating one because that's actually the recession that converted a lot of Americans to Keynesianism because it seemed like the government raised taxes slightly, cutting back on some expenditures. We have this very deep recession within a depression, really interrupted the recovery. It was basically a US phenomena. It wasn't a global phenomenon. Alvin Hansen, for example, that's when he sort of became converted to Keynes. The standard interpretation was fiscal policies had caused that. But then, Milton Friedman and Schwartz in the monetary history and others said, well, they were raising reserve requirements during this period, the Fed was, so there's a monetary aspect to it.

Irwin: So, there's been this debate about was it raising the reserve requirements or are some fiscal actions. But when I got into it, I can't remember exactly how I got into it. Oh, I think I, I got into it because after the great recession, people were worried about a double dip. So, 1937 was being brought up again and again is, how can we ensure that a smooth recovery, which begs the question of, well, what happened in 1937, '38. The reserve requirements just they weren't that big a movement. And so the question, how can you have this really big recession from this relatively small change? I found out you know, just through reading, that the treasury department started sterilizing gold imports.

Irwin: the US was a net recipient of gold from the rest of the world during this time, so we should have had nominal GDP rising. They were worried about inflation when inflation is like 3%, 4%.

Beckworth: Sounds familiar.

Irwin: They tightened by sterilizing gold imports. This is astounding because what that means is even though gold continues to come in, it doesn't become part of the monetary base, and the monetary base just comes flat. So instead of having it grow like at 3%, you'd like to grow in terms of the real economy, it goes to zero overnight and they maintain this for, I can't remember how long, but I think a about a year or so. It's really just putting the monetary brakes on the economy in a huge and very harsh and fast way. The timing of the gold sterilization, which they eventually did stop doing, it times perfectly with when the recession starts and when it ends, and that and that timing does not fit with the fiscal policy story.

Irwin: It doesn't really fit with the reserve requirement story. I just do some counterfactuals on what path was the monetary base and the money supply going on before that and after that. It just seems like there's a huge shock to the system.

Beckworth: It seems very convincing to me.

Irwin: It was not a Fed action. It was a treasury action.

Beckworth: That's what's fascinating. Why was the treasury concerned about inflation? That should've been the Fed's job, right? Why were they worried about inflation in the first place?

Irwin: Well, that's because the Fed and the treasury a little bit more tied back than today. We'd had this period of deflation, prices had stabilized and then we were coming up after we went off the gold standard, but they began to pick up an early '36. Surprisingly, even though we still had double digit unemployment, there was worried about overheating, war. You'd think after the price level falling by third, you actually wouldn't mind if it rose by a third, but instead, 5% or 6%, all of a sudden alarm bells go off. and they said, "We have to tighten.

Beckworth: A couple of things. This reminds me of the Eurozone. I think the Eurozone probably fits this the best because they too underwent the great recession in 2008. Then in 2011 ... Inflation is going up because the commodity prices, I think because they had bad tax their purely supplies shock they should've ignored, but they tightened twice in 2011. They were concerned about inflation. So again, the Eurozone is in the midst of just coming out of a great recession and they shoot themselves in the foot with these interest rate hikes because of inflation fears.

Beckworth: The other thing that makes me think of though is the great, going back to the early part of the great depression. The Fed was also very conservative then, right? It was almost reluctant to be aggressive. They had a little QE there, but it really was FDR who took the reins. Again, treasury took over in a more productive way. The world gold flows were coming in and treasury didn't sterilize them, right? During that period.

Irwin: Yeah. So this is where Christy Romer has a great paper in the journal of economic history on basically how monetary policy was on autopilot. It's not as though the Fed was trying to expand. We just had gold inflows and they just accommodated them. And so we got on this path, but it wasn't like they were super aggressive in an…

Beckworth: Then FDR also revalued the the dollar or more dollars per ounce of gold, which…

Irwin: Right. So there's a lot of fiddling with the dollar price in late 1933, and then 1934, they sort of pegged it again and then the gold influence just took us from there.

Beckworth: All right, those two things. We can't look to the Fed as an institution that saved us out of '33 and '34, is the treasury allowing the gold to come in and not sterilizing that time, whereas in '37, they go the other direction, which is just odd. I guess, at '33, 34 things are so bad. They're not worried about inflation, and then '37 they are right.

Irwin: Right,

Beckworth: Very fascinating. Okay. I believe our time is up. Our guest today has been Doug Irwin. Doug, thank you so much for coming on the show.

Irwin: Thanks for inviting me.

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